Inflation Adjusted
NYSE Stock Index

What is The True Stock Market Price (Inflation Adjusted)?

With the recent Wall Street crash and recovery, how
does the Stock Market compare? Where has the stock market
really gone over the long run? Is the upward trend
really just an illusion based on inflation?

Adjusting stock market prices for inflation using
the "Consumer Price Index" is known as the Stock
price in "real dollars". (A "real dollar" is the price after adjusting for
inflation).

One of the worst problems with inflation is that
distorts our perception... things are not always what
they seem and this introduces uncertainty into our decision
making process.

Here are some hypothetical scenarios:

The stock market went up 5% a year and inflation
went up 3%.

The stock market went up 5% a year and inflation
went up 5%.

The stock market went up 5% a year and inflation
went up 6%.

The stock market went down 5%
a year and inflation went up 2%.

In example #1 above inflation increased less than
the stock market so the real return is 5% minus 3% so
you had a "real return" of 2% (before taxes and after
the inflation adjustment).

In example #2 inflation increased the same as the
stock market so the real return is 5% minus 5% so you
broke even (before taxes). But after paying taxes on
the phantom gain of 5% you will actually lose money.

In example #3 above inflation increased more than
the stock market so the real return is 5% minus 6% so
you had a real loss of 1% (before taxes). But you will
still have to pay taxes on the 5% gain making your real
loss even worse.

In example #4 you have a 5% loss on the stocks plus
a 2% loss of purchasing power for a net loss of 7% but
you will be able to offset that somewhat by claiming
the stock loss on your taxes.

The most commonly mentioned method
to measure the stock market is the Dow Jones
Industrial average.

I have often wondered why this index is so widely
quoted by economic pundits, (other than the fact that
it was originally created on May 26, 1896, making it
the first index). At the time the DJIA represented the
average of twelve stocks from various important American
industries. Today the "DOW" is made up of 30 "representative"
stocks and it's composition has changed many times over
the last 100 plus years. Because the Dow takes out poor
performing stocks and replaces them with better performing
ones it has an inherent upward bias.

Rather than rely on "representative" stock indexes
I prefer the real thing so I have created this "inflation
adjusted stock price" chart by adjusting
for inflation on the entire New York Stock Exchange
(NYSE). The NYSE has the largest dollar volume of
any stock exchange in the world. About 2,800
companies, representing a market capitalization of
about $18 trillion, are listed on the NYSE,
so it gives us a much broader view of the stock market
than any 12 or 20 or 30 stocks could. In addition by
it's very nature it gives you an idea of how the
average investor would perform. After all, how
likely is it that you will pick the top performing
stocks without the benefit of hindsight? If you are
an average investor it is likely that you will end
up choosing stocks that will perform similar to the
average of the entire market.

Plus with only 30 stocks
a large move in any one of them could influence the
entire DOW index. There have been days when Microsoft or
Wal-Mart alone have created a significant move in the
index even if all the other 29 stocks were doing nothing.

Historical Commentary:

Let's look at the stock market and see how it has
fared in real inflation adjusted dollars compared
to previous years.

As you can see from the above chart the blue line
shows the "nominal NYSE index" (meaning the actual price
quoted by the media). To get the "Inflation Adjusted"
red line we adjust the stock price for inflation using
the Consumer Price Index (CPI-U) which is typically
referred to as the "Inflation Rate". This gives us the
price in terms of modern dollars. In other words, the
red line shows what the stock market would look like
if there was no such thing as inflation.

In nominal terms (blue line) the NYSE stock index
began 1966 just under 500. And by July of 1982 the nominal
stock index had increased to 615 after having been even
higher. So on the surface it would appear that the "stock
market" posted an increase of roughly 23%. (615-500=115)
and (115 ÷ 500=.23)

Now a 23% increase in 16 years would be a nominal
increase of 1.43% a year (less if you consider compounding)
which doesn't sound that great, but in those days stocks
paid higher dividends than they do today. So investors
expected to get their profit from dividends rather than
capital appreciation. So most investors would be happy
with a 23% increase in their stock portfolio over and
above their dividends.

The inflation adjusted stock price

However, when you adjust for the increase due to
inflation, we can see from the red line (which is the
"inflation adjusted NYSE Index stock price"
in current dollars) that in inflation adjusted dollars
the index began 1966 higher and actually fell through July of
1982.

So rather than a 23% increase, if you count inflation
and had held stocks for the 16 years from 1966 to 1982,
you would have actually lost about 59% of your
purchasing power due to inflation.

But to make matters worse you would have paid
taxes on your dividends and "paper gains" further
reducing your final remainder. This may be one
reason companies began reducing dividends, so more
money was pumped into increasing the stock price and
wasn't taxable until you actually sold.

Current Commentary:

In the time since 1982 the stock market has
increased both in nominal terms and in inflation
adjusted terms. Interestingly in inflation adjusted
terms the NYSE stock index is just slightly above
the peak of 2000. The August 2000 stock peak
occurred at around 6800 in nominal terms or 9346 in
June 2014 inflation
adjusted terms. So in 14 years the market has gone
from 9346 to about 10900 for a gain of about 16% or
nominally about 1.6% per year (less if you count
compounding).

The market peaked in August 2000 at 9337 in
inflation adjusted March 2016 dollars. Then it
bottomed in April 2002, and from there the market
moved higher until the July 2007 peak. This resulted is a 24.7% increase in seven
years from peak to peak or about 3.2% per year (compound
interest). After the 2007 peak the market lost about
50% of its value and then made a substantial
rebound, but in inflation adjusted terms the NYSE
has still not exceeded its 2007 highs. And in fact
returned to 2000 peak levels in January of 2016. So
from August 2000 to January 2016 the market went
exactly nowhere! (And that is using the
official BLS inflation numbers if inflation was
actually higher the market went less than nowhere it
actually lost money!)

Timing

In inflation adjusted terms, the market looked
very much like a "Head and Shoulders" with the 2000
peak being the left shoulder, the 2007 peak being
the head, and the February 2011 peak the beginning
of the right shoulder. The right shoulder has now
exceeded the inflation adjusted price for the left
shoulder so this has cancelled out the possibility
of this pattern. So, now we are in "no man's land".
The only caveat is that the timing from August 2000
to July 2007 was seven years. And we are now more
than 8 years since the 2007
crash. So we should be alert.

Our
NYSE - ROC (Rate of Change) chart tracks the nominal
rate of change in the NYSE and gives an excellent visual
presentation of stock market nominal rates of return
thus making it easier to determine when you should be
in the market and when you should be on the sidelines.